Using a Roth IRA as an emergency fund?

I have had and loved my Roth IRA over the last few years. I mean, it really is a great deal the government is offering us and I always wonder why more people aren’t taking advantage of it. First you put in after-tax dollars NOW and withdraw it when you retire TAX-FREE. There are some people who might still benefit from using a Traditional IRA (depending on their current and expected tax bracket) but I think the Roth IRA is a good idea for the majority.

As if the tax-free withdrawal wasn’t enough, the ROTH is more generous when compared to the Traditional IRA. One of my favorite things about it is that you can withdraw all of your contributions tax and penalty free. A few years ago, (I don’t remember why) I had some kind of emergency come up that I needed the money so I just withdrew the amount I had contributed to my Roth that year. I didn’t have any tax consequences or penalties to be paid.

Have you ever thought of your Roth as an Emergency Fund?

It turns out that quite a few people are using their ROTH as an Emergency fund because of this feature. The benefit to gain would be that the money could grow tax-free, but wouldn’t cost you anything to pull it out when the time came.

The downside I see is that if you are invested in stocks and mutual funds, then the value could fluctuate and you would hate to have to pull your funds out when prices are low (remember buy low, sell high?). But one commenter in the Wisebread forums brings up a good point…

“Well, your Roth doesn’t have to fluctuate very much if you invest it in a money market fund so I think it could work out just fine if you designate a small portion to be your emergency fund. For the last year I put my new Roth IRA contributions in a money market fund so in case I need the money I could use it.”

So by having the funds in a money market within a Roth IRA you could be avoiding the taxes on interest each year while avoiding market fluctuations.

Another commenter mentioned another reason to use a Roth…

“Retirement accounts are somewhat protected in cases of lawsuits, bankruptcy, etc. If you suffer a financial catastrophe, it might be really nice to have (some cash) to start over with.”

My thoughts about the Roth Emergency Fund

While I can see the benefit of using it, I think I would prefer to tier my emergency fund a bit. Maybe have $3-$5K in an ING Account, and then have the remainder of the funds in a Roth that you could access the funds in an emergency - but hopefully would never have to. Technically you could be missing out by paying taxes on the interest earned from the $3-$5K - but it would be minimal and it would probably make your life easier.
The other thing to consider is that this just blurs the line between Retirement savings and Emergency savings. As these lines become blurred there may be a tendency to “take tomorrow’s bread today” so to speak.
A couple related articles:

• Roth IRA as an Emergency Fund
• Withdrawing your Roth IRA contributions
  

Do you have a Roth Emergency Fund or would you consider creating one?

CPF Recommended Articles

• What is an IRA and do you need one?
• How to make money with a blog
• 10 free budgeting templates
• Tips on negotiating with credit card companies
• 23 ways to make extra money

Post from: Christian Personal Finance .com